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March 25, 2013

Altering of 401(k) Tax Incentives Alarms Retirement Industry

Impending changes, and concerns about possible changes, have the industry scrambling

The Employee Benefit Research Institute’s 2013 Retirement Confidence Survey recently found that 82% of workers participate in an employer-sponsored retirement plan, and an additional 8% have money in a plan they don’t contribute to. With so many people covered by 401(k)s, it’s clear that the impact of changes to their tax treatment could be substantial.

Protecting the tax incentives built into 401(k) plans is one of the biggest goals for The American Society of Pension Professionals and Actuaries (ASPPA). Unfortunately, tax changes that affect business owners could dissuade some employers from offering plans.

Brian Graff, executive director for ASPPA, spoke with AdvisorOne at the ASPPA 401(k) Summit on March 5 about the potential impact of changing those incentives. He referred to the Brookings Institution’s proposal that capped retirement savings deductions at 28%. Because business owners who offer their employers 401(k) plans are already taxed on contributions made to the plan and would be taxed again when they take a distribution, the proposal effectively calls for a double tax on retirement savings, he said. “No one likes taxes to begin with,” he said, so why would anyone want to pay twice?

Such a move could lead to declining savings rates among workers. Graff pointed out that investors are 14 times more likely to save if they have a plan through their employers than if they have to get an IRA on their own

Even so, since they allow investors to build tax-deferred income until distribution, IRAs are still valuable tools for retirement savings. “If you’re already maxed out [in your annual 401(k) contribution], it’s a great way to do supplemental savings,” Graff said.

Graff reminded us that Roth IRAs can’t be claimed as a deduction like traditional IRAs. He added that although the Roth conversion is not a “popular item” due to the subsequent increase in tax rates, the charitable rollover was extended in the American Taxpayer Relief Act of 2012 for rollovers made before Feb. 1. “It’s a way to make a contribution and avoid limits on items that apply in 2013,” Graff added.

Annuities’ tax-deferred growth is one of the biggest draws for investors. A report released in March by the Insured Retirement Institute found almost three-quarters of boomers consider tax deferral an important factor in picking any retirement product, and about 20% said it was their primary reason for owning an annuity specifically.

“One of the things annuities do is allow savings to grow faster,” Cathy Weatherford, president and CEO of the Insured Retirement Institute, told AdvisorOne on Friday. They’re especially helpful for investors who have contributed the maximum to their 401(k) allowed by the IRS ($17,000 in 2012 and $17,500 for 2013), she added, “you can add additional savings in a tax-deferred way.”

Weatherford pointed out that annuities are useful for people who don’t have access to other retirement plans. “Four in 10 workers don’t have access to a defined contribution retirement plan through their employer,” she said. “Using an annuity can help them get further down the road.”

Defined benefit plans have “gone the way of the dinosaur,” she said. Now employees have to take responsibility for their own retirements, and they’re using tax deferral as a way to “shore up” their savings. For employees who take assets out of their employer’s plan when they retire, “an annuity can be helpful in driving lifetime income” in a way that’s similar to what they would have gotten from a defined benefit plan.

“Our research has shown that Americans value tax deferral for retirement so they can save and build their nest egg without paying taxes on it while they’re still working,” she said. “Advisors have to remain vigilant, especially at a time when their clients are becoming more responsible for their retirement.

“It’s not that the federal government never gets that money. It’ll be taxed at distribution. It’s just a delayed entry into federal coffers.”

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